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PREVIEW OF CHAPTER 1 1-2 Intermediate Accounting IFRS 2nd Edition Kieso, Weygandt, and Warfield

1 Accounting Standards Financial Reporting and LEARNING OBJECTIVES After studying this chapter, you should be able to: 1. Describe the growing importance of global financial markets and its relation to financial reporting. 2. Identify the major financial statements and other means of financial reporting. 3. Explain how accounting assists in the efficient use of scarce resources. 5. Identify the objective of financial reporting. 6. Identify the major policy-setting bodies and their role in the standard-setting process. 7. Explain the meaning of IFRS. 8. Describe the challenges facing financial reporting. 4. Explain the need for high-quality standards. 1-3

GLOBAL MARKETS World markets are becoming increasingly intertwined. Top 20 Global Companies In Terms of Sales ILLUSTRATION 1-1 1-4 LO 1

GLOBAL MARKETS Significant number of foreign companies are found on national exchanges. ILLUSTRATION 1-2 International Exchange Statistics 1-5 LO 1

GLOBAL MARKETS Financial Statements and Financial Reporting Essential characteristics of accounting are: 1. the identification, measurement, and communication of financial information about 2. economic entities to 3. interested parties. 1-7 LO 2

GLOBAL MARKETS Economic Entity Financial Information Accounting? Identify and Measure and Communicate Financial Statements Statement of Financial Position Income Statement or Statement of Comprehensive Income Statement of Cash Flows Statement of Changes in Equity Note Disclosures Additional Information President s letter Prospectuses Reports filed with governmental agencies News releases Forecasts Environmental impact statements Etc. 1-8 LO 2

GLOBAL MARKETS Accounting and Capital Allocation Resources are limited. Efficient use of resources often determines whether a business thrives. ILLUSTRATION 1-3 Capital Allocation Process 1-10 LO 3

GLOBAL MARKETS High Quality Standards Globalization demands a single set of high-quality international accounting standards. Some elements: 1. Single set of high-quality accounting standards established by a single standard-setting body. 2. Consistency in application and interpretation. 3. Common disclosures. 4. Common high-quality auditing standards and practices. 5. Common approach to regulatory review and enforcement. 6. Education and training of market participants. (Continued) 1-12 LO 4

GLOBAL MARKETS High Quality Standards Globalization demands a single set of high-quality international accounting standards. Some elements: 7. Common delivery systems (e.g., extensible Business Reporting Language XBRL). 8. Common approach to corporate governance and legal frameworks around the world. 1-13 LO 4

1 Accounting Standards Financial Reporting and LEARNING OBJECTIVES After studying this chapter, you should be able to: 1. Describe the growing importance of global financial markets and its relation to financial reporting. 2. Identify the major financial statements and other means of financial reporting. 3. Explain how accounting assists in the efficient use of scarce resources. 4. Explain the need for high-quality standards. 5. Identify the objective of financial reporting. 6. Identify the major policy-setting bodies and their role in the standard-setting process. 7. Explain the meaning of IFRS. 8. Describe the challenges facing financial reporting. 1-14

OBJECTIVE OF FINANCIAL ACCOUNTING Objective: Provide financial information about the reporting entity that is useful to present and potential equity investors, lenders, and other creditors in making decisions about providing resources to the entity. 1-15 LO 5

OBJECTIVE OF FINANCIAL ACCOUNTING General-Purpose Financial Statements Provide financial reporting information to a wide variety of users. Provide the most useful information possible at the least cost. Equity Investors and Creditors Investors and creditors are the primary user group. 1-16 LO 5

DON T FORGET STEWARDSHIP In addition to providing decision-useful information about future cash flows, management also is accountable to investors for the custody and safekeeping of the company s economic resources and for their efficient and profitable use. For example, the management of Nestlé has the responsibility for protecting its economic resources from unfavorable effects of economic factors, such as price changes, and technological and social changes. Because Nestlé s performance in discharging its responsibilities (referred to as its stewardship responsibilities) usually affects its ability to generate net cash inflows, financial reporting may also provide decision-useful information to assess management performance in this role. [2] [2] The Conceptual Framework for Financial Reporting, Chapter 1, The Objective of General Purpose Financial Reporting (London, U.K.: IASB, September 2010), par. OB4. 1-17 LO 5

OBJECTIVE OF FINANCIAL ACCOUNTING Entity Perspective Companies viewed as separate and distinct from their owners (shareholders). Decision-Usefulness Investors are interested in assessing 1. the company s ability to generate net cash inflows and 2. management s ability to protect and enhance the capital providers investments. 1-18 LO 5

1 Accounting Standards Financial Reporting and LEARNING OBJECTIVES After studying this chapter, you should be able to: 1. Describe the growing importance of global financial markets and its relation to financial reporting. 2. Identify the major financial statements and other means of financial reporting. 3. Explain how accounting assists in the efficient use of scarce resources. 4. Explain the need for high-quality standards. 5. Identify the objective of financial reporting. 6. Identify the major policy-setting bodies and their role in the standardsetting process. 7. Explain the meaning of IFRS. 8. Describe the challenges facing financial reporting. 1-19

STANDARD-SETTING ORGANIZATIONS Main international standard-setting organization: International Accounting Standards Board (IASB) Issues International Financial Reporting Standards (IFRS). Standards used on most foreign exchanges. IFRS used in over 115 countries. Organizations that have a role in international standardsetting are the International Organization of Securities Commissions (IOSCO) and the IASB. 1-20 LO 6

STANDARD-SETTING ORGANIZATIONS International Organization of Securities Commissions (IOSCO) Does not set accounting standards. Dedicated to ensuring that global markets can operate in an efficient and effective basis. Supports the use of IFRS as the single set of international standards in cross-border offerings and listings. http://www.iosco.org/ 1-21 LO 6

HOW IS IT GOING? 1-22 How much progress has been made toward the goal of one single set of global accounting standards? To answer this question, the IASB conducted a major survey on IFRS adoption. The survey indicates that there is almost universal support (95 percent) for IFRS as the single set of global accounting standards. This includes those jurisdictions that have yet to make a decision on adopting IFRS, such as the United States. More than 80 percent of the jurisdictions report IFRS adoption for all (or in five cases, almost all) public companies. Most of the remaining 11 non-adopters have made significant progress toward IFRS adoption. Those jurisdictions that have adopted IFRS have made very few modifications to the standards. More than 40 percent of the IFRS adopters do so automatically, without an endorsement process. Where modifications have occurred, they are regarded as temporary arrangements to assist in the migration from national accounting standards to IFRS. (Continued) Source: Adapted from Hans Hoogervorst, Breaking the Boilerplate, IFRS Foundation Conference (June 13, 2013). LO 6

HOW IS IT GOING? How much progress has been made toward the goal of one single set of global accounting standards? To answer this question, the IASB conducted a major survey on IFRS adoption. The survey indicates that there is almost universal support (95 percent) for IFRS as the single set of global accounting standards. This includes those jurisdictions that have yet to make a decision on adopting IFRS, such as the United States. A few large and important economies have not yet (fully) adopted IFRS. In such countries, more progress is being made than many people are aware of. Japan already permits the use of full IFRS and has recently widened the scope of companies that are allowed to adopt it. In the United States, non-u.s. companies are allowed to use IFRS for listings on their exchanges. Today, more than 450 foreign private issuers are reporting using IFRS in U.S. regulatory filings, which represents trillions of dollars in market capitalization. 1-23 Source: Adapted from Hans Hoogervorst, Breaking the Boilerplate, IFRS Foundation Conference (June 13, 2013). LO 6

STANDARD-SETTING ORGANIZATIONS International Accounting Standards Board (IASB) Composed of four organizations IFRS Foundation International Accounting Standards Board (IASB) IFRS Advisory Council IFRS Interpretations Committee 1-24 LO 6

International Accounting Standards Board ILLUSTRATION 1-4 International Standard-Setting Structure 1-25 LO 6

STANDARD-SETTING ORGANIZATIONS Question IFRS stands for: a. International Federation of Reporting Services. b. Independent Financial Reporting Standards. c. International Financial Reporting Standards. d. Integrated Financial Reporting Services. 1-26 LO 6

STANDARD-SETTING ORGANIZATIONS Question The major key players on the international side are the: a. IASB and IFRS Advisory Council. b. IOSCO and the U.S. SEC. c. London Stock Exchange and International Securities Exchange. d. IASB and IOSCO. 1-27 LO 6

International Accounting Standards Board Due Process The IASB due process has the following elements: 1. Independent standard-setting board; 2. Thorough and systematic process for developing standards; 3. Engagement with investors, regulators, business leaders, and the global accountancy profession at every stage of the process; and 4. Collaborative efforts with the worldwide standard-setting community. 1-28 LO 6

International Accounting Standards Board ILLUSTRATION 1-5 International Standard-Setting Structure 1-29 LO 6

International Accounting Standards Board Question Accounting standard-setters use the following process in establishing international standards: a. Research, exposure draft, discussion paper, standard. b. Discussion paper, research, exposure draft, standard. c. Research, preliminary views, discussion paper, standard. d. Research, discussion paper, exposure draft, standard. 1-30 LO 6

International Accounting Standards Board Types of Pronouncements International Financial Reporting Standards. Conceptual Framework for Financial Reporting. International Financial Reporting Standards Interpretations. 1-31 LO 6

STANDARD-SETTING ORGANIZATIONS Hierarchy of IFRS Companies first look to: 1. International Financial Reporting Standards; International Financial Reporting Standards, International Accounting Standards (issued by the predecessor to the IASB), and IFRS interpretations originated by the IFRS Interpretations Committee (and its predecessor, the IAS Interpretations Committee); 2. The Conceptual Framework for Financial Reporting; and 3. Pronouncements of other standard-setting bodies that use a similar conceptual framework (e.g., U.S. GAAP). 1-33 LO 7

FINANCIAL REPORTING CHALLENGES IFRS in a Political Environment ILLUSTRATION 1-6 User Groups that Influence the Formulation of Accounting Standards 1-35 LO 8

FAIR CONSEQUENCES? No recent accounting issue better illustrates the economic consequences of accounting than the current debate over the use of fair value accounting for financial assets. The IASB has had long-standing standards requiring the use of fair value accounting for financial assets, such as investments and other financial instruments. Fair value provides the most relevant and reliable information for investors about these assets and liabilities. However, in the wake of the credit crisis of 2008, some countries, their central banks, and bank regulators wanted to suspend fair value accounting based on concerns that use of fair value accounting, which calls for recording significant losses on poorly performing loans and investments, would scare investors and depositors and lead to a run on the bank. Most notable was the lobbying of then French President Nicolas Sarkozy in urging his European Union counterparts to back changes to accounting rules and give banks and insurers some breathing space amid the market turmoil. Mr. Sarkozy sought agreement to new regulations, including changes to the mark-to-market accounting rules that have been blamed for aggravating the crisis. International regulators also have conducted studies of fair value accounting and its role in the credit crisis. It is unclear whether these political pressures will have an effect on fair value accounting, but there is no question that the issue has stirred significant worldwide political debate. In short, the numbers have consequences. 1-36 Source: Adapted from Ben Hall and Nikki Tait, Sarkozy Seeks EU Accounting Change, The Financial Times Limited (September 30, 2008). LO 8

FINANCIAL REPORTING CHALLENGES The Expectations Gap What the public thinks accountants should do vs. what accountants think they can do. Significant Financial Reporting Issues Non-financial measurements Forward-looking information Soft assets Timeliness 1-37 LO 8

FINANCIAL REPORTING CHALLENGES Ethics in the Environment of Financial Accounting Companies that concentrate on maximizing the bottom line, facing the challenges of competition, and stressing short-term results place accountants in an environment of conflict and pressure. IFRS do not always provide an answer. Technical competence is not enough when encountering ethical decisions. 1-38 LO 8

FINANCIAL REPORTING CHALLENGES International Convergence Examples of how convergence is occurring: 1. China s goal is to eliminate differences between its standards and IFRS. 2. Japan now permits the use of IFRS for domestic companies. 3. The IASB and the FASB have spent the last 12 years working to converge their standards. 4. Malaysia helped amend the accounting for agricultural assets. 5. Italy provided advice and counsel on the accounting for business combinations under common control. 1-39 LO 8

GLOBAL ACCOUNTING INSIGHTS INTERNATIONAL FINANCIAL REPORTING Most agree that there is a need for one set of international accounting standards. Here is why: Multinational corporations Mergers and acquisitions Information technology Financial markets 1-40

GLOBAL ACCOUNTING INSIGHTS Relevant Facts Following are the key similarities and differences between U.S. GAAP and IFRS related to the financial reporting environment. Similarities Generally accepted accounting principles (GAAP) for U.S. companies are developed by the Financial Accounting Standards Board (FASB). The FASB is a private organization. The U.S. Securities and Exchange Commission (SEC) exercises oversight over the actions of the FASB. The IASB is also a private organization. Oversight over the actions of the IASB is regulated by IOSCO. 1-41

GLOBAL ACCOUNTING INSIGHTS Relevant Facts Similarities Both the IASB and the FASB have essentially the same governance structure, that is, a Foundation that provides oversight, a Board, an Advisory Council, and an Interpretations Committee. The FASB relies on the U.S. SEC for regulation and enforcement of its standards. The IASB relies primarily on IOSCO for regulation and enforcement of its standards. Both the IASB and the FASB are working together to find common grounds for convergence. A good example is the recent issuance of a new standard on revenue recognition that both organizations support. Also, the Boards are working together on other substantial projects such as the measurement and classification of financial instruments. 1-42

GLOBAL ACCOUNTING INSIGHTS Relevant Facts Differences U.S. GAAP is more detailed or rules-based. IFRS tends to simpler and more flexible in the accounting and disclosure requirements. The difference in approach has resulted in a debate about the merits of principles-based versus rules-based standards. Differences between U.S. GAAP and IFRS should not be surprising because standard-setters have developed standards in response to different user needs. In some countries, the primary users of financial statements are private investors. In others, the primary users are tax authorities or central government planners. In the United States, investors and creditors have driven accounting-standard formulation. 1-43

GLOBAL ACCOUNTING INSIGHTS About The Numbers The IASB has looked to the United States to determine the structure it should follow in establishing IFRS. Presented is the FASB s standard-setting structure. 1-44

GLOBAL ACCOUNTING INSIGHTS On the Horizon Both the IASB and the FASB are hard at work developing standards that will lead to the elimination of major differences in the way certain transactions are accounted for and reported. In fact, beginning in 2010, the IASB (and the FASB on its joint projects with the IASB) started its policy of phasing in adoption of new major standards over several years. The major reason for this policy is to provide companies time to translate and implement international standards into practice. Much has happened in a very short period of time in the international accounting environment. It now appears likely that in a fairly short period of time, companies around the world will be close to using a single set of highquality accounting standards. 1-45

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PREVIEW OF CHAPTER 1-2